As part of the alternative asset brigade, private equity (PE) was by all accounts supposed to be going gangbusters this year, but fresh insights by global alternative asset manager GCM Grosvenor suggest market conditions have been cooling for the last three years.
What the Chicago-based GCM Grosvenor – which acts as the investment manager for the Pengana Private Equity Trust (ASX: PE1) - is witnessing is a significant slowdown in private equity realisations, which started back in 2022.
Private equity realisations is institutional investor-speak for the fine art by which a private equity firm simply sells its ownership stake in a portfolio company or asset to generate a capital gain and return cash proceeds to its investors.
While the slowdown in private equity realisation activity - within existing portfolios - coincided with interest rate rises back in 2022, what the market is yet to witness, notes GCM Grosvenor’s CIO Fred Pollock, is a valuation reset to reflect the higher cost of financing and lower valuation multiples relative to their publicly listed peers.
According to Pollock, 2023 recorded the lowest U.S. exit value in the past decade, which caused “quite a bit of heartburn in the ecosystem for private equity”.
Nowhere are the issues with private equity more evident than within GCM Grosvenor’s own management of the Pengana Private Equity Trust, with the investment portfolio trading at a current 17% discount to its net asset value.
Pollock attributes some of the slowdown to the market’s over-allocation to private equity, with many choosing to resolve the issue by offloading some of the maturer parts of the portfolio.
The trouble is when these assets come to market as secondary transactions - from one investor to another, while bypassing the original issuer – they tend to command a discount of 10-15% or more.
Pollock has also witnessed a significant rise in continuation vehicles.
In layman’s terms, these are investment structures in private equity that allow a fund manager to move one or more assets from an existing fund, nearing the end of its typical lifespan, to a new, separate vehicle also managed by the very same firm.
The trouble is, given that they weren’t the best assets, they were typically the ones they couldn’t sell.
However, the paradigm has changed completely, with Pollock witnessing a greater appetite by sponsors to hold onto these assets that are now seen as the crown jewels within a portfolio.
This gives the original investors the option to either cash out or roll their investment into the new fund.
“They don’t want to go to market and sell them to another sponsor who can capitalise on all of their hard work.”
By putting these assets into a single-asset secondary vehicle - or continuation vehicle - and raising capital around it, capital can be returned to investors who don’t want to roll into that transaction.
It’s the growth of this fund manager-led segment that’s now helping to drive the overall expansion of the secondary market, which is on track to set a second consecutive record for transaction volume.
“It didn’t really exist in that size or scope five or 10 years ago and now it’s nearly half the market,” notes Pollock, who says there are now a variety of structures globally designed to open access to private equity.
“The PE1 trust in Australia is another example. All of these structures represent different attempts to take private equity, which historically was only accessible by large institutions – and deliver it to individuals in a scaled, economically-efficient and institutional quality way,” he said.
Pollock notes that while these vehicles are widely discussed, the capital flowing through them remains relatively small.
“I think everyone’s expectation is that if you fast forward five, 10, 15 years, these vehicles, or other ones like them that are specifically designed for individual investors, start to become a very meaningful part of the pie in terms of the overall capital base that private equity is supported by.”
While these structures differ, what they all aim to address, adds Pollock, is the same basic challenge: How do I deliver institutional-quality private equity to individuals who previously couldn’t access it?
“Every year it’s a little bit more of a competitive market, it’s a little bit bigger. Things get more efficient, I would argue, as the market grows and competition increases,” Pollock said.
“The newer areas of activity, or the growing areas of activity, like single-asset secondaries and continuation vehicles, they are probably less mature, just because people are still figuring out that part of the market and it’s growing.”
